As in many countries, the UK’s health and welfare programmes are paid for by a separate tax called the National Insurance contributions. The current regime started in 1948 and is complex. The contributions are applied in four different “classes” – see here for the detail. They are calculated separately from income tax but administered by the National Insurance Contribution Office (NICO) in conjunction with tax.

 

The “class 1” contribution rates are as follows:

-          Employees: 11% of covered earnings:

-          Employers: 12.8% of covered earnings.

 

Then there are rebates where the pension scheme is contracted out of the State Second Pension (S2P), married women’s (lower) rates and separate rates for the self-employed, credits for the disabled, and so on.

 

When National Insurance started....

“Features of the scheme included:

 

Entitlement to many benefits depends on whether a claimant is or has been making contributions. For example, the age pension (‘Basic State Pension’) depends on a complete contribution record so that pensioners with a less-than-complete record receive smaller pensions. A working life can stretch over nearly five decades so the record-keeping function is significant. Until 2007, a ‘complete’ record for a male was 44 years; 40 for females. Now it is 30 years for both but achieving that doesn’t let contributors off the hook – they continue paying.

 

The original system had a card for each contributor. That was computerised in 1975 at the same time as the contribution collection process was attached to the PAYE tax system. In 2009, a new system was installed, combining the PAYE and National Insurance records. In fact, the NICO is part of the tax department (Her Majesty’s Revenue and Customs or HMRC). When that happened in 1999, there were 8,500 employees in the NICO. There are now only 3,400 (40% of the original tally) but the NICO still cost £70 million in 2009.

 

The report looks at the NICO’s push to reduce costs while, at the same time, improving performance. Technology is at the heart of the changes – for example, electronic filing is now required for all employers with more than 50 employees.

 

“The introduction of Lean methodology has enabled NICO to reduce staffing by over 500 people (around 15%) in the last 3 years, whilst improving performance with productivity increases averaging 15% to 30% in the main processes.”

 

With respect just to the state provision of incomes for the old, the UK has one of the most complex systems anywhere. Part of that is to do with the separation between ‘National Insurance’ and the government’s other system of income taxes and payments. 

 

Given that National Insurances contributions are the second largest source of revenue for the UK government (at £98 billion in 2009), there seems a case to consider changing the contributions-based system of entitlements in favour of benefits that are paid direct from general tax revenue. The marginal cost of collecting extra income tax (equal to £98 billion) would be somewhat less than present arrangements.

 

Delinking benefits from contributions would also allow for a considerable simplification of current entitlements. That would help citizens to better understand those and to make easier the decision as to whether additional, private provision were needed. It would also allow the current ‘contracting-out’ provisions that apply to the S2P to be eliminated. PensionReforms thinks that would be an improvement in benefit design anyway but it would also have the advantage, again, of simplying the pensions environment.

 

However, none of that will happen. Instead, the UK will be adding soft compulsion (with new contribution rules) in the shape of the new Personal pension Accounts on top of an already numbingly complex framework.

 

The NICO has done a good job in the last 11 years or so to improve the collection of National Insurance contributions while at the same time taking large costs out of the system. In PensionReforms’ view, the pity of that effort is that it still maintains the separate stream of tax collections that operate in an entirely different way from income tax, even sometimes perversely. They are regressive at the lowest and highest income levels by comparison with income tax with the exemptions that can apply to that.  It should be time for a radical re-think but PensionReforms does not expect that. (File size 105KB; 18 pp) 388